The Politics of Assumptions [Reader Post]

Today we hear about deficit reduction budgets from both sides of the aisle. But what is never discussed are the economic assumptions that accompany deficit reduction budgets. Here is a very good article by James Pethokoukis about economic assumptions and their affects on projections. This post draws heavily upon his article.

Economic Assumptions and Their Effects

The budget that President Obama proposed on Monday [in July, 2011] is highly dependent on economic growth forecasts for the next decade that are significantly higher than the Congressional Budget Office (CBO) has projected. Philip Klein at The American Spectator has compared WH projections and CBO projections of real GDP growth out until 2021. What he found is remarkable. Using CBO estimates, deficits are projected to be $1.11 trillion lower than when WH assumptions are used. BTW, the WH assumptions were calculated by OMB director Jack Lew (we learn more about him below).

How Did We Get Here?

Ed Dolan, economist, author, and blogger, has a very good article about economic assumptions and their effects on political decisions affecting us all. He states that the proposed FY2012 budget looks not only at 2012, but necessarily into the future.

Looking at the budget deficit, it is expected to be 10.9 percent of GDP in 2011, to fall to 7 percent in FY 2012, to 4.6 percent in 2013, and 3.6 percent in 2014. Some of the deficit decrease is to come from spending cuts and measures to enhance revenues, but most of it comes from assumed improvements in the economy. Real GDP growth, which is expected to be 2.6 percent this year, is assumed to rise to 3.6 in FY2012, and then to 4.4, and 4.3 percent in the next two years. At the same time the unemployment rate is supposed to fall steadily from 9.6 percent in 2011, to 8.6, 7.5, and 6.6 percent for 2012 through 2014. However, if the assumed improvements in the economy don’t materialize, neither will the deficit reductions.

All of the above assumptions/estimates come the Office of Management and Budget (OMB). The tendency of the OMB toward budget optimism is well documented in the OMB’s own data base regarding economic growth. The same “bias” of underestimation can be seen when the OMB projects unemployment figures. The OMB’s forecasts cannot be expected to be exactly accurate every year. Economic forecasting is an inexact art. What we hope for would be unbiased forecasts that would miss on one side as often as the other, unlike those of the OMB. The bias toward optimism in assumptions contributed to the budget mess the United States finds itself in today. BTW, the head of the OMB is Jack Lew, an Obama appointee. And here is an article about Heather Higginbottom, Obama’s nominee for deputy director of OMB, and her answers about the accuracy of statements the president and OMB Director Jack Lew have made that the proposed FY2012 budget will not add to the national debt.

“Although we can’t yet compare actual with assumed values for FY 2012, the economic assumptions in the just-published budget may once again turn out to be overoptimistic,” states Dolan.

In the debt-ceiling negotiations, word is that the economic situation is worse than thought. Commerce Department figures show the gross domestic product (GDP) growing at an anemic 1.3 percent rate in the second quarter of 2011. The initial first-quarter 1.9 percent figure was downgraded to 0.4 percent. If the second-quarter rate is later reduced that much, it would signal that the country is in a recession. GDP growth numbers raise questions about the economic assumptions on which the budget projections and debt-ceiling plans are based. Revenue projections assume an unrealistic growth rate of nearly 3 percent through 2020. Economic numbers show the widening gap between Obama’s promised economic performance and what he has delivered.

Obama’s Assumptions

About Obama’s budget speech he gave last week (13 Apr 11): “When he made his big budget speech last week, it wasn’t at all clear from where his numbers were coming – nor in what direction they were heading,” said Pethokoukis. “A “fact sheet” on his “Framework for Shared Prosperity and Shared Fiscal Responsibility” gave a few more specifics, but little or no context to make real sense of them. Even for seasoned budget experts, it was a puzzlement.”

Budget experts think Obama used his own more optimistic forecast numbers to prepare budgets. From 2012-2015, Obama sees the economy growing at a pace of 3.6 percent, 4.4 percent, 4.3 percent and 3.8 percent. The CBO sees slower growth, 3.1 percent, 3.1 percent, 3.5 percent, 3.8 percent. For the rest of the decade, Obama assumes GDP growth an average of 0.2 percentage point faster than the CBO. When CBO ran Obama’s numbers with its own growth forecast, it found that Obama raised $1.7 trillion less than his OMB had predicted. Obama also assumes those higher growth rates would be possible despite the heavier tax burden. When Goldman Sachs looked at the numbers, they think Obama was measuring his savings against the CBO’s estimate of what it considers the most likely budget path. Over ten years, Obama’s plan saves about $2.2 trillion less than Representative Paul Ryan’s – and that’s still giving Obama his rosy economic forecast from above. But Obama’s assumptions were based on no tax increase impact. Obama reiterated his pledge to let $1 trillion worth of top-end Bush tax cuts expire. That means Obama is actually calling for $2 trillion worth of tax hikes, not $1 trillion.

From the Senate Budget Committee, we learn: “CBO Confirms: Obama’s Budget Assumptions Were Detached From Reality. The budget that the Obama Administration presented to Congress on February 14th pushes our nation further down an unsustainable path: growing the government, weakening the economy, and increasing the burden of debt on each and every American. Now, the Congressional Budget Office has confirmed that the president’s budget conceals an additional $2.3 trillion in deficits.”

So what do Obama’s assumptions mean for us taxpayers? From this source we learn a few things about Obama’s proposed FY2012 budget. Obama’s budget assumes that the U.S. will experience economic growth of over 5 percent for most of the coming decade. That is so far-fetched that “optimistic” is not the right word for it. It also assumes that U.S. government income will more than double over the next ten years. His budget proposal does not even attempt to make any cuts to entitlement programs such as Social Security and Medicare. Meanwhile, the U.S. national debt is currently increasing by approximately 4 billion dollars every single day.

Comparing Apples to Oranges

Finally, Obama’s budget calls for a 12-year budget instead of a customary 10-year plan. Former Bush II economic adviser Keith Hennessey said: “He wanted to claim that he was “matching” the Ryan plan in deficit reduction, but was just achieving that same goal in a better way. Matching Republican deficit reduction is a linchpin of the President’s fiscal argument. He was short by a trillion dollars or more, so he and his team decided to measure his proposal over a different timeframe and hope no one would notice.”

So there you have it. The Obama deficit reduction plan (?) makes some unrealistic assumptions and tries to sneak in a time-line change.

Are States Any Better?

As Thomas Sowell points out in this article, “Anyone who says that we don’t have the money to pay what was promised is accused of trying to destroy Social Security, Medicare or ObamaCare – or whatever other unfunded promises have been made. It is like blaming the bank for saying the check bounced.”

And, he continues, states are not doing much better. He offers the state of Florida as an example. Florida’s own estimate of its pension fund’s shortfall is based on assuming that they will receive a rate of return of 7.75%. But what if it turns out that they don’t get that high a return? A 6% rate of return would more than triple the size of Florida’s unfunded liability for its employees’ pension. The actual rate of return that Florida has received over the past decade has been only 2.6%. In other words, by simply assuming a far higher future rate of return on their investments than they have received in the past, Florida politicians can deceive the public as to how deep a hole the state’s finances are in. [emphasis mine]

So what does all of this mean?

The next time you see an assumption/projection, ask (specifically) on what assumptions was the projection made. Then ask yourself: “Are those assumptions realistic?” Also, read the “fine print.” Someone just may be trying to slip one past you!

But that’s just my opinion.